Fed deploys write-down strategy to aid struggling mortgage holders

January 29, 2009|By Maura Reynolds, Washington bureau

WASHINGTON — The Federal Reserve, in a move that could point the way toward breaking the logjam at the center of the credit crisis, has adopted a new strategy to permit some troubled borrowers to reduce the amount they owe and refinance into more manageable mortgages.

It is likely to set the stage for a broader Obama administration attack on the foreclosure crisis.

The policy of reducing the principal balance of the loan, adopted without fanfare by Fed governors last week and disclosed to key lawmakers Tuesday, came as the central bank said Wednesday it would continue to hold its benchmark interest rate around zero percent and pursue more innovative ways to repair the nation's broken credit markets.

"Credit conditions for households and firms remain extremely tight," the Fed's interest rate-setting committee said in a statement.

The Fed is the first major mortgage-holder to explicitly endorse principal write-downs. Other government-endorsed loan modifications permit lower interest rates and longer terms but not principal write-downs.

"There's been an increase in loan modifications, but none of them have involved principal reductions," said Guy Cecala, publisher of Inside Mortgage Finance, a trade publication.

Officially, the new policy applies only to mortgages the Fed controls through three companies formed to hold mortgage-related assets it acquired last year from the collapse of investment house Bear Stearns and insurer AIG. Those three companies hold roughly $74 billion in assets, including residential and commercial mortgages.

That is only a fraction of the total troubled mortgages and mortgage-backed securities, but the Fed has been in talks with the Obama administration about a broader program, and it is likely that the new Fed policy reflects the direction of those talks.

Dean Baker, a housing expert and co-founder of the Center for Economic and Policy Research in Washington, said the new Fed policy can be seen as a harbinger of programs to come.

"It's hard to believe that the Fed would go ahead with something that flouted what the Obama administration wanted," Baker said. "It's likely they are thinking along comparable lines, even if not the exact same program."

Even so, Baker said, the new Fed policy is likely to have greater reach in coming months, as any bank-rescue plan announced by the administration is likely to include a role for the Fed in overseeing or managing the toxic mortgage-related assets that have corroded banks' balance sheets.

President Barack Obama's new Treasury secretary, Timothy Geithner, reiterated Wednesday that the administration is working on a sweeping new plan to stabilize the banking sector and address the growing tide of mortgage foreclosures.

"We are putting together what we hope will be a comprehensive plan for helping repair the financial system and bring recovery," Geithner said.

He indicated that although the administration still is weighing options for how to fix the financial system, it is leaning away from nationalizing troubled banks.

"We have a financial system that is run by private shareholders, managed by private institutions, and we'd like to do our best to preserve that system," Geithner said.

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Who's eligible?

Under the Federal Reserve's new mortgage policy to reduce the principal balance of some loans, priority would be given when the home's value has fallen 25 percent or more. Eligible homeowners must live in their homes, have verifiable income and be at least 60 days delinquent in payments or show they will be unable to make payments because of a "trigger event" such as an interest rate reset or job loss.